Get a guaranteed income stream¹ while taking advantage—to some extent—of stock market booms.

 

One of the more jarring aspects of retirement is going from the security of a regular paycheck to the confusion of liquidating your multiple retirement accounts. Thatʼs why many people choose to annuitize a portion of their savings—meaning convert that portion into a series of periodic income payments. It guarantees an income floor to cover everyday expenses and often provides a little peace of mind.

 

How long you receive that income is defined in advance (10 years, 25 years, maybe even for the rest of your life), but the amount you receive is not necessarily fixed; it can vary based on how well the underlying stocks are performing. Thatʼs the fundamental difference between a fixed and a variable annuity.

 

Both types have something to offer: Fixed annuities provide some level of certainty and peace of mind—youʼre guaranteed a fixed rate of return (which may or may not be inflation-adjusted) by the insurance company, which invests your principal as they see fit—while variable annuities allow you to choose from a selection of investments that offer the potential for growth.

 

Indexed annuities: Having your cake and eating it?

If you are seeking the protection and security of a fixed income, with the opportunity to benefit from the market booms a variable annuity accommodates, you may want to consider indexed annuities, a kind of fixed/variable hybrid designed to appeal to conservative investors. If youʼre one of them, weigh the pros and cons of this enticing product carefully:

 

  • There is a limit on the amount of market returns you can get in any given year. For example, if your indexed annuity is capped at 5%, say, and the market returns 3% in one year, you will benefit fully from that 3% growth. However, if market returns are 10% the following year, youʼll only receive 5% of it. Remember, the market tends to see big upward and downward swings, so there will be years with bumper returns that you cannot benefit from. But while thereʼs a limit to just how high you can go before hitting a ceiling, you can only go so low before hitting a floor: Strictly speaking, indexed annuities are a type of fixed annuity, so youʼre guaranteed a minimum amount of income.
  • Another thing to consider is the annual annuity fees, on top of the fees you may wind up paying for the underlying investments. It is vital that you research these fees because, by definition, an indexed annuity means you give up the unlimited upside of direct stock market exposure. Before committing to an indexed annuity, make sure you understand all associated fees.
  • Additionally, because annuities are set up to provide you with income over the long term, there frequently are (often high) penalties for breaking your contract and liquidating your annuity before a set number of years have passed. If you decide to cancel your annuity and access your funds early, you could be looking at cancellation fees as well as a tax penalty.

 

And if you want to withdraw your money before a certain period of time has elapsed (typically seven years), you may have to pay a surrender charge. As such, youʼll want to think long and hard about whether you are willing to have your money tied up in this relatively illiquid manner before investing in an annuity.

 

Bottom line:

The great thing about annuities is the steady stream of income. Indexed annuities often appeal to people who understand the importance of growth but want to put a floor on the amount of losses they might suffer. In other words, people who are not so much risk averse as loss-averse. If youʼre one of them, carefully consider the costs and the limitations of this product, balanced out against the strengths and benefits.

 

¹ Based on the claims-paying ability of the issuer

 

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